Turning to Gold in an Era of Deflation

A knee-jerk reaction to the recent stock market rally coupled with disappointment in gold’s eight-point decline on April 5, 2016 might cause some investors to turn away from gold. Such a reaction would be a big mistake on the part of the serious investor.

Markets go up; markets go down. But what you should be looking for, as you develop value in your portfolio, is the long-term trend — not just a simple blip on the radar screen. Day-trading or short-term trading in any market can be costly, unless you’re a professional trader or money manager.

Shaky investor confidence rocked the equities markets in the first six weeks of 2016. Even though stocks rallied around February 11, the decline was sufficient to motivate investors to flock to gold as a safe haven. Gold is negatively correlated to the stock market, so it wasn’t entirely surprising when it exploded to the upside over 16%. A rally in commodities also helped the gold market. But when stocks began to fail earlier in the year, panicking investors craved a safe outlet for funds normally earmarked for stocks.

What gives gold its special appeal right now is its safe-haven status in an era of global economic contraction and deflation. Ordinarily, gold offers protection against inflation. The classic definition of inflation is when too many dollars chase too few goods.

In other words, if it costs, say, $10.00 to purchase a widget, and next month it costs $11.00 to purchase the same widget, the rate of inflation is 10% a month. In fact, this rate of inflation – 10% a month – is typically defined as hyperinflation. And it’s this economic condition we’re seeing in Argentina and Venezuela right now.

While hyperinflation is toxic, an economy does need some inflation. To grow, companies need to raise their prices in order to be able to reinvest and expand.

But when a country’s rate of inflation grows too fast, its currency debases and its consumers’ savings shrink. Gold is appealing in an inflationary era because, unlike fiat currency, it holds its value. As a hard asset with limited above-ground supplies, gold has a value that builds. And so, investors will flock to it as a safe haven when the value of their dollars or other fiat currency dwindles through inflation.

But what we’re encountering right now in the world at large, including the United States and Europe, is just the opposite. We’re getting deflation. And deflation is also not a good thing for the economy.

With deflation, a country finds itself in slow or, worse, no growth, since its businesses are inhibited from investing or raising prices. Central banks, including our own Fed have thrown up their hands because they’ve run out of tools to counteract deflation. The Fed and the European Central Bank (ECB) have tried quantitative easing (printing money) and lowering interest rates to no avail. Several European countries, Denmark, Sweden and Switzerland have introduced negative rates of interest to motivate depositors to spend their money to stimulate the economy. In other words, banks in these countries are now charging depositors just to keep money in the bank.

Back in November, Janet Yellen told the U.S. Senate banking committee that the Fed might consider negative interest rates if economic conditions in the U.S. warranted such a move.

One of the reasons gold has had a record first quarter in 2016 is fear of negative interest rates. Traditionally, investors will choose an interest-bearing account over gold because the yellow metal is a non-interest bearing asset. But investors are now beginning to reason if they’re going to be punished for keeping money in the bank, they’d be better off invested in gold.

The short of it is we now have proof that gold can serve you well both in inflationary and deflationary times. This is why it’s best not to try and guess when to invest in gold. Buy a little bit of physical gold every month. It’s a perennial investment – one that will work for you all the time, in all economic contingencies.